Canadian energy sector at risk due to surging U.S. energy production

U.S. production of oil and gas is surging. This is great news for America, which should be able to reduce its reliance on energy imported from unstable or undemocratic regimes in places like Venezuela and the Middle East.

It creates the opportunity for a very different approach to U.S. energy policy and foreign policy. But it could be very bad news for Canadian energy companies and governments; can we gain a growing share of a shrinking U.S. energy import pie, while diversifying into global markets?

The almost-daily debate over the Keystone pipeline—will President Obama approve it, or won’t he?—has captured the Canadian public’s attention because of its impact on the price that oil producers in Canada, and the governments that tax them, currently receive for their product.

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Construction of Keystone would help to reduce the bitumen price discount, improve the profitability of current and future oil sands production, and increase the flow of royalties to the provinces and tax dollars to the federal and provincial governments.

But there is an even bigger issue rising south of the 49th parallel, which is the surge in the production of oil and gas in the U.S. The combination of ever-more sophisticated horizontal drilling technologies and water fractionation (or fracking) have opened up access to more and more supplies of oil and gas within the continental United States.

The U.S. government and the International Energy Agency (IEA) have repeatedly raised their estimates of U.S. oil and gas production in recent years. After declining for decades, U.S. oil production is up more than 40% from 2008, when production bottomed out, and recently eclipsed 7 million barrels per day—a level not seen since 1992.

For the longer term, a two-part strategy is required

All of this increase can be attributed to the production of what is called “tight oil”, which is extracted from shale and other tight rock formations. Tight oil production leaped from 0.8 million barrels a day in 2010 to 2.0 million barrels a day in 2012. The Bakken field in North Dakota (plus parts of Montana and Saskatchewan) is the source of most of this spectacular growth in tight oil production.

As a consequence, and importantly for Canadian energy producers, the U.S. will now be able to reduce its reliance on oil imports. The IEA estimates that the U.S. will be able to cut its oil import bill in half in volume terms by 2020. This is particularly troublesome for Canada as we have provided for 20% of all oil imports into the U.S. over the past decade — more than all the Persian Gulf countries combined.

This is a game-changer for the U.S. in terms of both energy policy and foreign policy. America can now become a supplier as well as a buyer in global oil and gas markets, taking advantage of any price differential between global and North American energy markets. And U.S. foreign policy may not have to be driven so often by events in the Middle East.

But for Canada, growing U.S. energy self-reliance presents a huge challenge. As my colleague Michael Burt described in his recent commentary “The Tyranny of the Single (Energy) Buyer,” we are dependent on one foreign buyer for most of our energy sales. When that buyer suddenly has options, the need to diversify our client list is obvious, even if Canada’s long democratic traditions plays to our advantage in capturing energy market share in the U.S.

So what can Canadian firms and governments do? In the short term, securing enhanced access to the U.S. energy market through the approval of Keystone is imperative. But for the longer term, a two-part strategy is required: first, expanding access to global markets to ensure that we do not face an energy price (and royalty) discount on a permanent basis; and second, working to maintain and even grow our energy market share in the U.S.

Part one of the strategy means developing a diversified energy transmission infrastructure as a top national priority, with all the players—business, federal and provincial governments, organized labour and other stakeholders, notably First Nations—sitting at one table and setting an agreed common strategy.

Part two of the strategy requires adequate North American energy infrastructure and regulatory alignment, but it also means enhancing the energy industry’s “social license to operate” through a comprehensive policy that demonstrates Canada’s commitment to sustainable energy development, particularly addressing the rising production of greenhouse gases. Reducing greenhouse gas intensity per unit of output is a good start, but only a start.

In short, rising U.S. energy production is a game-changer for Canada. And when the game changes, you either change your own game—or you lose out.

Glen Hodgson is the senior vice-president and chief economist, forecasting and analysis, at The Conference Board of Canada